Target-date fund disclosures miss the point

Commentary: Labor Dept. proposals won’t end investors’ confusion

BOSTON (MarketWatch) — The federal government wants investors to have better information about the mutual funds in their retirement plans. Washington has the right idea, but the wrong solution.

That’s the conclusion to be drawn from the Department of Labor’s proposed new disclosures for target-date funds offered in 401(k) programs. Target-date funds are increasingly popular, and are the default option in many plans for workers who do not actively select their own investments.

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The proposal — if it gets through the comment period and is implemented — would force plan sponsors to disclose a fund’s asset allocation and how that mix of assets changes over time (with graphics!). Investors would be told the significance of the actual target date, and the fund’s investment policy, including a statement that the fund has the risk of losing money, even as the shareholder nears retirement.

That’s nice, but not meaningful. Most firms with target-date funds give something resembling that information now, but many shareholders don’t bother to read it, or can’t understand it. The DOL’s Employee Benefits Security Administration could have pushed for substantive change to clear up confusion, but that might have involved upsetting some fund companies. As a result — much like the Securities & Exchange Commission, which is also looking at issues surrounding target-date funds — the Labor Department is settling for cosmetic change.

To retirement, or beyond

Target-date funds mature with the investor, becoming more conservative near the target, but how they age depends entirely on the way the fund is structured. Whether you call them target-date, life-cycle or retirement-year funds, the issue is that the public can’t tell by looking at the retirement year what the fund is going to do.

The big issue comes down to a simple question: “To, or through?”

Some target-date funds are designed to get shareholders to retirement age, so that they become most conservative in the latter years of the employee’s working life. Others are built to get buyers through the rest of their life. As the retirement target year approaches, these funds are not even close to their most conservative asset allocation, because given average life expectancies, the portfolios still need to generate decades of growth.

That difference in purpose shows up in performance. A 2010 target-date fund that was at its most conservative allocation in 2008 — a miserable year for stock investors — could have avoided a lot of the market’s pain. A fund with the same target-date, but the longer, longevity-based glide path, would have paid a steep price for being more aggressive.

For a worker set to retire in 2010, that difference is very real. If the employee planned to buy an annuity to help fund retirement, the loss of purchasing power at the point of retirement will affect their income for the rest of their life.

Time and tolerance

There are definitely times when a strong market would give the edge to the “through fund,” the one with the longer time horizon. The investor can’t know what the market will do in advance, but they should know when their fund will be at its most conservative allocation.

Patrick Cunningham, chief executive officer at Manning & Napier, which specializes in target-date issues, noted that investors should be looking at target-date funds according to their needs and plans. “If I think I am going to roll out of the plan when I am 65, I want my portfolio to be at its most conservative as I reach retirement, so I want a ‘to’ fund,” Cunningham said. “And if I plan to stick with what I have for the rest of my life or far into retirement, then I want a ‘through’ fund. It’s pretty easy when you think about it that way.”

Alas, the Department of Labor didn’t think in those terms, or it would have required common disclosure language, either that “This fund is built to get you to retirement in the target year, and you may need to reallocate your assets thereafter,” or “This fund will age with you for the rest of your life.” Instead, expect complicated investment-policy statements and graphic timelines of how the asset allocation changes.

Moreover, most 401(k) plans have one type of target-date fund, either “to” or “through,” so the consumer isn’t making a choice so much as living with what their employer offers.

If your employer has a “to” fund, but you plan to stick with it for life, you would actually want to push back the target, so that someone with a 2010 target might instead buy a 2040 fund. And if the employer offers “through” funds but you want to be most conservative right before quitting the job, you would bring the target forward, so a 2040 retiree would want a 2010 fund.

Unless the retirement-planning market picks a style and makes it the standard, confusion will be part of the equation. Workers can avoid the mess by building their own asset allocations, rather than having life-cycle and target-date issues as their default options, but until target-date operations are clearly defined, they will not be the set-it-and-forget-it option that regulators and fund firms make them out to be.

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